Revisions to the Standardised Approach for credit risk

On 10 December 2015 the Basel Committee on Banking Supervision published the second consultative document on Revisions to the Standardised Approach for credit risk.

The main objectives pursued by the Basel Committee can be summarized in the following points:

• reducing mechanistic reliance on credit rating agency ratings,
• strengthening of banks´ own due diligence and internal risk management,
• balancing risk sensitivity and complexity to ensure that the standardised approach (STA) constitutes a suitable alternative and complement to the Internal Ratings-Based (IRB) approach,
• removing of unnecessary national discretions,
• aligning the STA and the IRB definitions and taxonomy, where possible,
• promoting comparability of capital requirements by reducing variability in risk-weighted assets across banks and jurisdictions.

The second consultative version differs in several aspects from the first consultative document published by the Committee in December 2014. The first version of the review removed all references to external credit ratings and assigned risk weights based on a limited number of alternative risk drivers. The consultation, however, showed that no equivalent substitutes are available for ratings and that the complete removal of references to ratings is not necessary and desirable. The Committee has decided to reintroduce the ratings for exposures to banks and corporates but they must be used in a non-mechanistic way and completed by stronger internal due diligence and internal risk management procedures. The revised proposal also includes alternative approaches for jurisdictions that do not allow the use of external ratings for regulatory purposes.

Moreover, the Basel Committee introduces important changes in the structure of exposure categories. It proposes to categorize all exposures related to real estate under the same asset class, and apply higher risk weights to real estate exposures where repayment is materially dependent on the cash flows generated by the property securing the exposure. While the current STA includes a category for past due loans, the Committee now declares that the past due concept should apply to all assets and not just loans. In addition, the definition of past due should be as far as possible aligned with the IRB’s “defaulted exposure” definition. Therefore, this category has been renamed to defaulted exposures.

The proposed revisions also relate to the credit risk mitigation framework. Consistent with the first consultative document, the Committee maintains the removal of internal models and own estimates of haircuts for calculating capital requirements under the STA. In compliance with the current proposal for risk weighting, the external ratings should be retained in the credit risk mitigation framework in order to promote risk sensitivity and reduce complexity.

The STA treatment for sovereigns, central banks and public sector entities is out of the scope of the proposal. This proposal is pending and the Committee is considering these exposures as part of a broader review of sovereign-related risks.

The public consultation is open by 11 March 2016.